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Limited Liability Company: What Is It And How Is It Different?

Limited Liability Company: What Is It And How Is It Different?

Pedro Araez945 21-Sep-2021

There are a few kinds of business structures, and if you’ve seen a limited liability company (LLC), it’s not recognized everywhere for a few reasons. An LLC also differs from other forms because it protects the people behind it. A business registered as an LLC is a hybrid model that combines a sole proprietorship or partnership and a corporation. Here are other things you need to know about an LLC.

It’s Flexible

One of the reasons entrepreneurs are setting up businesses as LLCs is they’re allowed to choose tax treatments. They can pay taxes the way a sole proprietorship, partnership, or S or C corporation does.

As an example, let's look at a single-member LLC, which is a Limited Liability Company that only has one owner. This type of LLC is taxed via personal income tax. Ultimately, the gains and losses attributed to the LLC would not need to be reported separately. Instead, the LLC owner can go online to file a tax return or sit down with a tax preparer—whatever means they normally use—and report gains and losses on the Schedule C that's attached to the usual 1040 personal income tax form.

 

The setup offers the opportunity for the business to become a flow-through entity where the income it makes goes straight to the owner, investors, or shareholders. Business owners can avoid double taxation this way. If the business owners have agreed on partnership taxation, the income is allotted to all shareholders different from their percentage of ownership.

It’s State Regulated

Rules governing LLCs vary, depending on the state where they’re based. This influences how the company acts in different situations. Those who want to start an LLC must first research more about the basics and the filing fees, depending on state laws, and if their target business name exists.

In some states, an LLC would be dissolved if a member of the organization dies. It’s different from other states where the LLC would continue to operate and the shares of the deceased member would be handed to the executor.

When deciding on an operating agreement, the members would have to form it based on existing resolutions of the state. The operating agreement is an essential document they cannot ignore. Its creation is the only way they can be allowed to run a business.

Another consideration the owners must take into account is its place in the international business scene. Other countries may classify LLC as a corporation because it may not be recognized overseas.

It Limits Personal Liability

Businesses running as LLCs are legally separate from their owners. Legal liabilities and debts cannot touch the owners, similar to how shareholders cannot be held liable in a corporation. However, there may exist a risk that the owner may lose their contribution to the enterprise, but the owner’s assets remain untouchable.

Owners can also make a business continuation agreement if one of them passes away or leaves the company. The deal is vital because they’d need to dissolve the current LLC and start a new one. This can be time-consuming on everyone’s part.

It Involves Less Documentation

Large corporations also offer limited liability, just like LLCs. But for them to continue operating, they must comply with certain requirements, which usually don’t apply to smaller businesses, especially if they’re informal.

With corporations, there must be meetings of shareholders, payment of annual fees, and organization of reports that state the business's status. Corporation record keeping is a must to keep track of their overall condition. Sometimes, they may also enlist the help of tech companies offering database development services to manage their records smoothly.

On the other hand, businesses classified as LLCs don’t come with regular meetings, reports, or strict monitoring. Smaller companies with one or two owners can run the business with minimal requirements because, unlike corporations, they don’t hold as many obligations.

It Uses Cash Method Accounting

C corporations make use of accrual accounting, a method that records income and expenses as they occur rather than when payment has been received. This means the corporation would have to wait for the actual cash. And regardless of when the cash is received, the accounting department already counts this as valuable. This method is suitable for corporations as it involves monthly reporting.

However, it might not be advisable for LLCs, which may not have sufficient staff to do it. As such, LLCs use cash-basis accounting, like many businesses do, and acknowledge revenue once cash is received. This accounting method doesn’t recognize accounts payables and receivables. And it’s much simpler to maintain as the money is actually received. With the cash method, you can easily monitor how much cash is already on the company’s side. Moreover, it allows you to make immediate but sound decisions without waiting for enough capital.

Limited Liability Company: What Is It And How Is It Different?
 

 

It’s Not Exempt From Self-Employment Taxes

Businesses that are categorized as LLCs may avoid double taxation, but they’re not exempt from self-employment taxes. Taxes are still paid twice because you’re both the team member and employer of the business. Depending on the state where the company operates, the owner must pay an annual fee for the limited liability benefits that the members enjoy. The annual fee may cost around USD$800 and may increase depending on the income of the LLC.

The Members Can Deduct Losses

In an LLC, members can deduct the operating losses against their regular income, albeit limited to an extent by law. Your share of the losses will pass through the business on its way to your tax return. You can get the adjusted gross income by adding all the business losses and other deductions and then subtracting them from the annual income.

You’ll see if you have a net operating loss if the losses exceeded the income from every source throughout the year. But you can still consider significant tax benefits advantageous because operating losses lessen your tax liability.

Members Can Decide How Profits Are Shared

Another advantage of LLCs is that members can determine how to allocate profits as stated in the operating agreement. Unlike other business structures, members can decide how profits are divided, which are not limited to their ownership proportion. One example of this is when a member can take less than their agreed share of the profits if another member decides to put more time and effort into the company's daily operations. But in certain situations that may put an LLC’s solvency in danger, they may not choose to distribute profits.

In Conclusion

LLCs apply to smaller businesses that are also a combination of other business models. Some entrepreneurs choose this business structure because it mainly protects their assets from debts and liabilities. However, they’re also aware of the disadvantages that come with it.


 


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